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Fitch affirms county utility system revenues at 'A-'; outlook stable

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Fitch Ratings affirms the 'A-' rating on Los Alamos (the Utility) approximately $47 million utility system revenue bonds, series 2004 and 2006. The Rating Outlook on all bonds is Stable.

RATING RATIONALE:

--Stable Financial Performance: The combined utility continues to generate healthy profit margins averaging 7.2% since fiscal 2006, and reported low system leverage (4.8 times [x] debt-to-funds available for debt service [FADS]), adequate debt service coverage (1.42x) and healthy liquidity (125 days cash on hand [DCOH]) in 2010;

--Customer Concentration Risk: Credit risks include a high customer concentration risk. The Los Alamos National Laboratory (LANL) accounts for over 53% of the operating revenues. However, this is partly mitigated by the relative stability exhibited by LANL over the past few years and the lab's importance to U.S. national security.

--Manageable Capital Program: The combined system has a 10-year capital program sized at a manageable $97 million. Electric system projects will be funded 80% by the Department of Energy (DOE) and the remaining 20% will be financed through incremental utility rate increases. Water and sewer projects will be financed with a mix of state grants/loans, utility rates and county participation;

--Narrow Service Area Economics: The combined system has a heavy dependence on LANL operations which currently account for approximately 64% of the county's employment.

RATING DRIVERS:

Significant and drastic reduction in LANL's workforce that would severely impact the county's economic stability and the generation of utility revenues could result in downward pressure on the rating and/or Outlook.

SECURITY:

Bonds are secured by, and payable from, the pledge of the trust estate, which includes net revenues and moneys in the acquisition fund, the bond fund and the rate stabilization reserve fund.

CREDIT SUMMARY:

Los Alamos Utility System is a combined utility system, providing electric (71% of revenues), natural gas (14%), water (8.5%) and wastewater (6.2%) services to Los Alamos County. The county is located in northern New Mexico, approximately 35 miles northwest of Santa Fe. Superior wealth and employment levels highlight LANL's primary role in fostering a strong local economy. Currently, LANL employs approximately 11,000 employees or 64% of the county. Unemployment stood at 3% in 2010, up from 2.6% in fiscal 2008.

The recent Las Conchas wildfire that prompted the evacuation of more than 10,000 residents in the town has been contained and the Los Alamos Lab unscathed. LANL was shut down for over a week because of the fire's proximity to 20,000 barrels of nuclear waste. Management indicated minor infrastructure damage to some of the Utility's lines and to the water reservoir. The extent of the financial impact on the Utility's revenues is still under evaluation but Management expects the impact to be minimal.

The closure of LANL or a significant staff reduction that severely impacts the service area and utility sales and cash flow, remains the system's principal credit risk, but is mitigated by LANL's long-term viability and its strategic importance to national defense programs. Going forward, LANL's load is projected to increase twofold by fiscal 2015. Management is confident that the utility will be able to meet the additional demand and is currently evaluating alternatives that include spot market purchases, ownership in new sources, and block power purchases.

The county and LANL own and operate ample generation resources and have an agreement to pool these resources for a more efficient dispatch. The county owns or has contracts for approximately 74 megawatts (MW) of generation and has transmission contracts to deliver the energy from those facilities to the Los Alamos service area. The DOE owns two approximately 20 MW generation units that are located on site at LANL, both of which are currently for emergency generation only. Additionally, the DOE has contracts with the federal Western Area Power Administration (WAPA) for up to 12 MW of hydroelectric capacity and owns and operates one of the two 115-kilovolt (KV) electric transmission lines that service the county.

The combined Utility system's financial performance is healthy. Fiscal 2010 revenues remained flat at $56.9 million following a drop of 4.2% in fiscal 2009. Operating expenses increased by 3.1% to $53.8 million in 2010 compared to a 2.6% drop in the previous year.

Fitch expects management's near- to medium-term utility rate increases to continue supporting coverage at current levels. Fitch-calculated debt service coverage for 2010 (1.42x) falls below the median for the Fitch rating category, but is still considered adequate. Coverage for fiscal 2011 is expected to improve. The Utility has solid liquidity. Despite the draws on unrestricted cash in fiscal 2010 to finance capital projects, a $15 million balance was maintained, consistent with historical levels. Leverage is expected to decline going forward as the series 2004A bonds matures in 2015.

Fitch views the Utility's management of rates in concert with capital expenditures as prudent and flexible. Rates for each system are competitive relative to neighboring systems except for the wastewater system which are above average due to recent major capital improvements. The Utility anticipates modest increases in electric and gas distribution rates ranging between 4% and 6% in the next 10 years and more aggressive increases of 5%-20% in water and wastewater to fund the Utility's upcoming capital program.